Union Pacific held its 2024 Investor Day on Sept. 19. Following are takeaways from analysts at TD Cowen, Susquehanna Financial Group and Loop Capital Markets. UP’s slide presentation can downloaded below.
Jason Seidl (Railway Age Wall Street Contributing Editor), Elliot Alper and Uday Khanapurkar, TD Cowen
UNP showcased its growth initiatives and deep bench at its Investor Day in Dallas. The long-term outlook appears achievable, though macro-pegged guidance may result in a lower top line. Productivity improvements led by tech should help offset structural cost headwinds. International intermodal poses mix challenges to near-term yields.
UNP covered all the tracks during its two-day investor day that showcased technology advancements at its Dallas Intermodal Terminal (DIT, a 300-plus-acre terminal in a fast-growing market), and management from across the organization to understand the levers for growth at UNP while introducing three-year financial outlook.
There have been 182 track construction projects completed from 2021-2024 YTD that generate $700MM of revenue annually. There are currently 200-plus construction projects in the pipeline that offer $1.6B in revenue opportunities, which come with “great margins.” UNP has a team that works with RE developers to offer shovel ready sites for customers.
Mexico remains a key growth lever, with $140B of announced investment in Mexico and more is expected, particularly in the automotive space. UNP offers the shortest and fasted routes seven days a week and currently has 60% of the rail share in Mexico already. We believe that if 1) we have a pro trade White House and 2) USMCA trade remains intact, this could open the flood gates for new investments in Mexico.
UNP plans for $100MM in productivity over the next three years in technology. UNP also plans to leverage AI training models to expand IM capabilities and enhance terminal command centers. Automation (which we saw at DIT with operations like autonomous track systems) should drive more efficiencies in the network.
UNP offered three-year financial guidance that we believe to be very achievable. UNP expects revenues to outpace volume and looked at economic indicators (industrial production, consumer spending, autos, housing) to gauge growth projections. High-single to low-double-digit EPS CAGR over the next three years falls short of our 15% growth assumption in 2025 (consensus forecast has 12% growth next year), though we note the low end of the EPS range is where the S&P global forecasts are (which assume muted growth). Capex of $3.5-3.7B annually falls short of the previous benchmark of 15% of revenue, as management alluded to potential productivity enhancements. UNP expects to repurchase $4.5B of stock annually at the midpoint and maintains a 45% dividend payout ratio.
Customers are looking to partner with UNP as service quality improves and service offerings expand; LA/Chicago premium service and new expansions will cater to the growth at the Gulf ports. Customers typically look for six months of quality service before moving freight onto rail. Over the past four years, UNP has reduced locomotive dwell by 35%, with six of those points this year. More investments in the next few years (double-tracking, investing in manifest terminals, adopted tech) should enable UNP to see continued improvement in velocity.
Bascome Majors, Harrison Bauer and Hannah Zhang, Susquehanna Financial Group
UNP’s macro/market-relative mid-term outlook matched our view of reasonable expectations heading into CEO Jim Vena’s first investor day, and steady absolute capex suggests any cyclical upside can drive FCF (free cash flow) higher to the benefit of shareholders.
UNP’s first multi-year strategic outlook with Jim Vena at the helm was mostly in line with our expectations. Specifically, we weren’t surprised by a ~10% headline EPS CAGR, underpinned by a macro/market-relative volume and revenue outlook, expectations for improving pricing and moderating rail cost inflation vs. recent years (~3.5% still above longer-term ~2.5% but aligned with union wage deals struck early at other rails), no explicit OR target besides a desire to continue to lead the industry (with Vena pointing to a ~2% point spread as a good target), an unchanged ~45% dividend payout ratio, and a return to $4-$5B in annual buybacks starting next year.
While it didn’t get attention in the Q&A, we were encouraged by the steady absolute capex guide of $3.5B-$3.7B (12-14% current consensus 2025-27 revenue) after upside here drove lowered FCF expectations at another rail last year. We understand some investors’ disappointment in the lack of a hard margin guide. But we believe Vena’s insinuation of conservatism in the overall view, a clear desire to lead the industry on margin and modest macro assumptions underpinning the forecast were as much as could be reasonably expected in the context of a still-activist STB and UNP’s desire to demonstrate growth in the business vs. a still-uncertain industrial macro backdrop.
Long-term financial targets: Throughout the 2025-2027 period, UNP expects revenue (ex-fuel) to grow faster than ex-coal volumes (consensus revenue growth for FY25/26 is +5%). On the yield side of the top-line, the railroad anticipates pricing dollars will be accretive to operating ratio starting in 2025 (estimating cost inflation of +3.5% over the period). While not quantifying a margin outlook, UNP expects to maintain an “industry-leading operating ratio” with Vena suggesting a ~2% point spread vs. peers as a good target (FY24-26 consensus ORs of 60.0%, 58.2%, 57.5%, respectively). Layering in annual share repurchases of $4B-$5B (starting in 2025, roughly 3% of current market cap annually), UNP expects to compound EPS growth at a high-single-digit to low double-digit percentage range from 2025-2027 (vs. FY25/26 consensus EPS of +12%/10%).
Long-term growth engines: While UNP purposely didn’t provide specific volume growth targets to underpin its earnings guidance, it did note that macro core assumptions support the lower end of the company’s long-term range (which would be a high-single-digit percentage ’25-’27 EPS CAGR). Still, UNP outlined several key growth markets of Grain, Petrochemicals, Mexico and truckload conversion, as well as a keen focus on various business development and real estate projects along the existing network.
Rick Paterson, Loop Capital Markets
Union Pacific put together a well organized investor event, including a Dallas Intermodal Terminal visit and good access to management for sideline conversations (thanks Eric Gehringer). These events are a ton of work, and we thank Investor Relations and support staff for the successful effort in this regard. We do, however, have an issue with some of the substance…
Playing the Same Old Game
Prior to traveling to Dallas we attended the STB Growth Hearing in D.C., where we made the case that it’s time to start to move away from the 20-year strategy of price-driven operating ratio reduction, given the pricing story has faded and a consequence of this strategy has been negative volume growth and the declining relevance of the railroads in the U.S. economy. Then we flew to Dallas and hear Union Pacific’s strategy is to “maximize price” to reduce and maintain an “industry leading operating ratio.”
Now, to be fair, management was presenting to a room full of people that care a lot about price-driven operating ratio, and in their shoes we might be saying the same thing, but the broader strategy Union Pacific laid out on Thursday just isn’t going to fix the volume growth problem, in our view (assuming they even want to). Let’s put some numbers around that problem …
This table shows Union Pacific’s volume growth performance over the past 20 years (2024E vs. 2004, down 13%) and past ten years (2024E vs. 2014, down 16%):
Our estimate for 2024 simply applies the YTD growth rates to full-year 2023 volumes. We’ve consolidated volumes into 16 categories, and it’s a depressing picture. Over the past 20 years only 7 of the 16 have grown, and it’s worse over the past decade, with only 5 of the 16 increasing, including only 1 (chemicals) of the top 8 by volume. Union Pacific is, quite simply, a shrinking business across most of its products. Now, if this is the scale of the problem, did we hear a strategy on Thursday commensurate with this challenge? Not in our view.
Yes, service has improved somewhat, due in part to better crew availability (which we love). Yes, Union Pacific’s EVP of Sales showed a map with lots of colored dots on it that represents expansion opportunities, but every railroad does that at every conference. Compared to prior UP strategies, it felt like more of the same and the result is probably going to be the same—a lower-volume business by the time we get to the next investor day. We can basically write up Jim Vena’s legacy as UP CEO right now: “Improved service a bit but didn’t change Union Pacific’s poor volume growth trajectory.” Sorry, but that’s how we see it. We like how Mr. Vena speaks about growth and his “coal is no excuse” mantra, but from our vantage point the strategy looks underwhelming relative to the problem. Prove us wrong.
The shame of it is that, to grow volumes, everybody knows what needs to be done. Every customer panel at the STB hearing repeated the list, yet again, of the things that would make an immediate and tangible difference in terms of their rail share of wallet vs. trucks:
- Price: More modest and, ideally, service-linked price increases is a big one, but that’s obviously not going to fly at UP and the Class I’s more broadly.
- Service consistency across the full business cycle: Crushingly difficult for a network of UP’s scale and complexity.
Others on the list are more achievable:
• Customer service: Small customers still say they often cannot get through to Class I Customer Service, and even big customers say they can’t get someone on the phone consistently. Union Pacific is a giant company with huge resources, so why can’t Customer Service be staffed up to the point that every customer can get a live, knowledgeable person on the phone or a prompt call back? Being pushed to an AI chatbot doesn’t count.
• Switching frequency: The customer asks for seven day per week service at its facility and the railroad gives them five. Another customer asks for five day per week service and the railroad gives them three. A big customer asks for two switches per day and the railroad gives them one. One of the reasons short lines tend to grow faster is that they reverse this, giving customers increased switching frequency. Why can’t UP do this? What’s the percentage difference between the number of switches requested by customers and those provided by the railroad? What’s the strategy to shrink the difference? Has any Class I experimented with giving the merchandise customer base slightly more switches than requested rather than materially less, to see what happens to customer satisfaction and volumes?
• Missed switches: If a customer is switched Mon.-Wed.-Fri. at a facility and the railroad misses the Friday, then customer product and rail assets dwell for five days. How many missed switches occur on UP per week and what’s the strategy to bring this down?
• Demurrage: The railroad delivers loaded cars to a customer facility two days early. The customer has no incoming visibility and doesn’t expect them, isn’t staffed to unload them, and ends up incurring demurrage charges for not releasing the empties back to the railroad in a timely manner. This generates ill will. What’s the strategy for determining which charges are fair (customer’s fault) and charged, and which are unfair (railroad’s fault) and should not be charged. Demurrage and detention are supposed to influence customer behavior in a way that keeps assets turning, rather than a profit center. We question whether we’re straying a little into the latter.
We obviously don’t work for a railroad, and we’re spit-balling a bit here, but you get the idea. These are some of the tangible things that matter in terms of volume growth. You just won’t hear them mentioned at an investor day. Union Pacific will either figure out a way to do them better, and they’ll grow, or they won’t, and they won’t.
We’d like to thank the Surface Transportation Board for being friendly and efficient hosts during last week’s hearing on the growth challenges facing the U.S. Class I railroads. Our slide deck and written testimony are available HERE (scroll way down). Our view doesn’t represent the Wall Street consensus, to the extent there is one.
